Austrian Economics FAQ Version 1.1 Authors: The Staff of The Austrian Economics Discord Server™ Description: This is a collection of Frequently-Asked-Questions concerning Austrian Economics and the Austrian perspective on economic issues. It covers a wide range of issues, from the foundations of economic analysis to business cycle theory. References: Most questions are accompanied by references to further reading on the topic as well. The most common references are to the two great treatises within Austrian Economics, Human Action by Ludwig von Mises and Man, Economy, and State by Murray Rothbard. All references can be found for free online in PDF form. Foundations: What is praxeology? Praxeology is the study of all of the implications logically deducible from one singular statement: the action axiom. This foundational axiom simply posits that “man acts”. From this one statement, all the conclusions of the science of praxeology are logically and a priori drawn. These include the concepts of means and ends, marginal utility, the Law of Demand, and more. *References: Human Action Chapter I ; Man, Economy, and State Chapter 1 * What does it mean for a person to act? Action in the Praxeological sense of the word means that man seeks after ends, and that he employs means to attain those ends. The ends that man wishes to achieve could be almost anything imaginable. One could have the desire to make a sandwich, buy a new car, or solve mathematical equations. From a praxeological standpoint, we do not question the ends that acting man chooses. Praxeology does not approve or disapprove of a man’s desired ends, just acknowledge that he does seek after those ends. Similarly, praxeology does not confer any sense of validation on the means that one chooses to attain his desired ends. One may believe that the best means to attain the end of graduating college is to sleep through lectures and ignore deadlines. It could result that these means are wholly unsuited to attaining the ends one seeks, but it is not the task of praxeology to discern the best means for the attainment of ends, only to analyze from an impartial perspective that actors do employ means to the attainment of ends. *References: Human Action Chapter I ; Man, Economy, and State Chapter 1 * What is marginal utility? Marginal Utility is the praxeological statement that the value that acting man confers upon any good is dependent on the end that particular good will satisfy. If I possess only one good of a particular stock, then I will value that particular good more than if I was in possession of ten goods of that stock. This is because as my stock of goods increases, the ends that I can satisfy with them decreases. The first good I acquire will naturally be allocated to satisfying my highest desired end that good is fit to satisfy. The second good I acquire will satisfy the second-highest desired end, and so on. Thus, the value placed on any particular unit of a good is a function of the stock already in my possession, as contrasted with the ends I can satisfy with that stock. The value therein derived is the marginal utility of that good. *References: Man, Economy, and State Chapter 1.5 ; Human Action Chapter VII.1 * What is the law of Diminishing Marginal Utility? The law of diminishing marginal utility is derived from the concept of marginal utility, and it states that as the stock of a good increases, the marginal utility of increasing the existing stock by another unit decreases. If I am in possession of a single good, the addition of one more unit of that good will be much higher than if I was already in possession of one hundred units of that good. As my stock increases, I can satisfy increasing amounts of my desired ends. As more and more of my ends are satisfied, the utility I derive from the newly satisfied ends decreases. Thus, as the stock of a good increases, the utility I derive from additional marginal units of that same good will decrease. *References: Man, Economy, and State Chapter 1.5 * What is the Law of Demand? The Law of Demand is the praxeological law that states that as the price of a good increases, the demand decreases. The opposite is also true; as price decreases, demand increases. This law of economics can be derived from a simple understanding of action, utility, and costs. If the price of a good increases, this means that the amount of ends I would be able to satisfy if I purchased the good would be less than at the previous price. Thus, as the price increases, there will inevitably come a point where the costs of the ends foregone outweighs the utility provided by purchasing the good. Thus, we can say that as the price of a good increases, the demand for that good will decrease. This same logic applies to the increase scenario as well. As the price decreases, there will come a point where purchasing the good will generate greater utility than abstaining from that purchase. As a result, we can state that as price decrease, demand will increase. What is the Law of Supply? The Law of Supply is related to the Law of Demand, viewing the same phenomena through the lens of supply. The Law of Supply states that as the price of a good increases, the amount of that good supplied on market will increase. Vise versa, if the price of a good decreases, the amount of that good supplied on market will decrease. This law, similar to its demand-based counterpart, is also derived from praxeology. As the potential utility gained from undertaking an action increases, the likelihood of engaging in that action increases as well. We can see this very clearly in the production of goods and services. An increase in the amount of money paid for the purchase of a good represents an increase in the potential utility that one could gain from engaging in that production process. Therefore, as the price, also seen as the potential income for the producer, increases, the amount of that good supplied on markets will increase as well. What is time preference? The concept of time preference deals with the one’s chosen ratio of immediate consumption to future consumption. If I choose to spend all of my time picking apples off of trees and eating them on the spot, I am only engaging in direct and present consumption. In other words, I am only consuming and not saving. If, however, I decide to put away some of my apples to eat in the future, I am no longer working only to eat in the present, but also in the future. I am engaging in saving so that I may have a stock of goods to consume in the future. One’s degree of time preference depends on one’s amount of consumption relative to one’s saving. *References: Human Action Chapter XXVIII ; Man, Economy, and State Chapter 6.3 * What does it mean to have high time preference? Individuals with high time preference have very high levels of consumption relative to their saving levels. They relatively prefer to enjoy in the present as opposed to enjoying in the future. *References: Human Action Chapter XXVIII ; Man, Economy, and State Chapter 6.3 * What does it mean to have low time preference? Individuals with low time preference have low degrees of consumption relative to their savings. They prefer to consume in the future as opposed to consuming in the present. *References: Human Action Chapter XXVIII ; Man, Economy, and State Chapter 6.3 * What does it mean for production to be roundabout? Roundaboutness refers to the relative amount of stages that one utilizes in a production process. If I go into the woods to pick berries, this production process has only one stage. This single stage is that of my entering the woods and picking the berries. However, if I decide that building a bag to hold my berries in would allow me to carry more berries, then I must first construct a bag with the materials I have on hand, and then go into the woods to collect more berries. This production process is relatively more roundabout, as there are now two stages where there was previously only one. My first stage is to build a bag, and the second is to go and collect berries. Therefore, this production process takes more time and is more arduous than the first. I must go through the work and toil of creating a bag before I am able to collect my berries. However, this process is also more productive than the first. I am able to take more berries back with me, and thus, am able to consume more than I was before. Whether or not the time and labor associated with this more roundabout process will be outweighed by the additional consumption allocated to me is up to my own subjective utility and time preference. *References: Man, Economy, and State Chapter 6.2 * What is autistic exchange? All action represents an exchange. For one to act, there must be a felt uneasiness about the future. One wishes for things to be different than the way that there are or will become. Therefore, one is impelled towards action. If there was no uneasiness about the future, one would not be driven to action as there would be no motivating factor. Consequently, we can say that in acting one is always attempting to trade the set of circumstances as they would have been in one had not acted for the set of circumstances one is looking to bring about as a result of acting. In this way, all action is an exchange. Acting means to exchange what one has for what one wishes to have. It is this exchange that is meant when we refer to “Autistic Exchange”. *References: Human Action Chapter X.1 * What is Austrian Economics, and what makes it different from the mainstream? Austrian Economics differs from Neoclassical (Mainstream) Economics in many different ways. Some of these are minor disparities, while others are major differences in thought. For the sake of summary, we will examine two of the largest points of contention between Austrians and Neoclassicals: methodology and understanding of the market. Austrians understand Praxeology to serve as the basis of economic analysis. We start from an understanding of the actions of man more broadly, and then apply this to questions relevant to economics. All of these conclusions are logically derived one from the other, all starting with the statement that “humans act”. Neoclassical thought has no such corollary to the Austrian embrace of praxeology. The methodology of the Neoclassical school is very empirical in nature, but also much less coherent than the Austrian approach. The Neoclassical approach to economic science is to apply the methods of the natural sciences to the actions of individuals to discover laws of economics. Just as the scientist performs experiments in the laboratory, the economist performs experiments of his own by examining and contrasting economic data and statistics. The way in which Neoclassical economists and Austrian economists view the market is also different in both its nature and scope. Austrians view the market as being a process. The market takes place in time, and thus, is constantly in a process of moving and adjusting to the wishes of those that engage in it. It is constantly moving toward an equilibrium state, but never reaches this state. The Neoclassical view of the market is focused on examining equilibrium states within the market, even if those equilibrium states never actually result. When looking at the market or the economy as a whole, the Neoclassical will utilize general equilibrium models, in contrast to the singular partial equilibrium for a single market. *References: Human Action Chapter II and Chapter XV * Why do Austrians think people are always rational? The Austrian view of rationality and the Neoclassical understanding of rationality are very different in their scope and view of human nature. The Neoclassical view is that individuals are always looking to maximize their utility, discoverable through an analysis of indifference curves and budget restraints. This near-robotic view of action is the “homo-economicus”. Neoclassical economists would not claim that human beings actually act in this way, but that this model gives us fairly strong predictions about how people act. Austrians view rationality in a completely different framework. For the Austrian, rationality is always a question of what the actor believes will maximize his utility. Because actors always look to maximize their utility in their action, we can state that man’s action is always rational. To even say “rational action” is unnecessary, as action is always ration by virtue of it being undertaken by the actor. *References: Human Action Chapter IV.1 * Why do Austrians rely on verbal logic not symbolic logic? When speaking of praxeology and the nature of acting man, Austrians could very well utilize symbolic over verbal logic. When we state that an actor employs means for the attainment of ends, we could alternatively write that A implies Q , where A is anything that is an actor and Q is the achievement of ends through various means. However, there is nothing gained from this translation of verbal into symbolic logic. Everything that was contained within our verbal statement is equally present within our symbolic statement. Thus, the utilization of symbolic logic in the field of economics cannot provide us with any new information. This does not mean that it cannot be useful, just that it reveals nothing new to us. We could write out all of the laws of economics in terms of symbolic logic, but such an exercise is doubtful to help our understanding of these laws in any tangible way. *References: Man, Economy, and State Chapter 1 Appendix A * What is a Whig view of history in regards to science? The Whig Theory of History is the idea that the progress of man kind is ever increasing as time moves along. Every now and then there might be a few bumps in the world, World War 2 and the Black Death being prime examples, but on net, mankind gets better as time moves along. Applied to science, the Whig theory would state that as time goes on, science becomes more and more correct in its theories and conclusions. Again, there might be a few regressions, but we will be smarter tomorrow than we were today, and smarter 10 years from now than we are today. What is the difference between socialism, capitalism, and interventionism? Socialism is the form of economic organization where all of the means of production are owned by the state. Private business does not exist, and the production of all the goods and services in the economy is overseen by a governmental central authority. Capitalism is the exact inverse of Socialism. Under Capitalism, all production of goods and services is carried out by private businesses. The government has no presence at all in the economy, and prices are free to move and fluctuate according to market forces. Interventionism is Capitalism, but with a government presence in the market. This could be government-run services or utilities, such as the post office. This could also be government mandated floors or ceilings on prices; the most famous of these are minimum wage and rent control. Whatever the form it takes, Interventionism is marked by a government role in the affairs of the economy such that not all goods and services are subject to private production at pure market prices. *References: Man, Economy, and State Chapter 12 * What is uncertainty? Uncertainty is a product of man’s lack of knowledge concerning future events. In his action, he does not know with total assurance what his environment will look like in an hour, a day, or a year. As such, he must estimate to the best of his ability a picture of the future as it would affect him and his action. Because of the presence of uncertainty, however, this picture is never concrete. Uncertainty affects all of action, and particularly action on markets. Entrepreneurs are always uncertain about future market prices. However, in the pursuit of profits, they must continually look to predictions on what they believe the future may resemble, and adjust their actions accordingly. If they believe that the price of a certain good will rise, they will invest in the production of that good. If they believe the price will fall, they will divest themselves of that good’s production. *References: Human Action Chapter VI * Do Austrians reject empirical knowledge? Austrians do not reject empirical knowledge per se. Utilization of empirical methods has generated great progress in the fields of the natural sciences. Empirical knowledge, as such, is perfectly fine and good. However, this does not mean that empirical knowledge is applicable evenly to all sciences. Just because a method of inquiry performs well in one area does not mean that this success can be replicated elsewhere. Economics is one such field where empirical methods fail. Praxeology reveals to us what action is and all that it entails. However, there are no constant laws concerning the content of human action. Because value judgments of man can always change, the actions we take are subsequently subject to eternal change as well. Consequently, any empirical findings we may discover are not necessarily true. They are information about past events. What happened in the past can certainly influence the present, but this does not mean that past actions must be replicated in any way in the present. Any such “laws” derived from empirical findings concerning the past are therefore not laws at all, but fallacious interpretations of the actions of yesteryear. Empirical methods cannot reveal laws concerning the content of human action because no such laws can ever truly exist. *References: Human Action Chapter II * Markets: What is Catallactics? Catallactics is the study of the market and market exchange. Praxeology grants to us laws concerning the nature of human action, and Catallactics is the application of those laws to market situations and circumstances. Topics such as exchange, markets, equilibrium, and interest all are Catallactic in nature. Even more complex subjects, such as business cycle theory or capital theory would also be considered Catallactics as well. *References: Human Action Chapter XIV * What is Elasticity? Elasticity refers to the change in the amount of a product sold as compared with a change in price. If the price of a good increases, and the quantity demanded decreases by more than the price increase, demand for that good is elastic. If the quantity demanded decreases by less than the price increase, demand for that good is inelastic. If the quantity demanded decreases by exactly the amount of the price decrease, than the demand is unit elastic. *References: Man, Economy, and State Chapter 2.5 * What does it mean for a market to be competitive? The Austrian understanding of competition is process based. The competitive process involves firms all offering the best possible products to consumers at the best possible price. Consumers will buy from those entrepreneurs who fulfill their wants and abstain from buying from those that do not. All those that deliver goods the consumers wish to purchase will be “rewarded”, while those that do not are “punished”. The competitive process is the constant changing and evaluation of those entrepreneurs that satisfy consumer demand. Competition is not dependent on the number of firms present, but on the continual process of creating and improving the development of goods and services to consumers *References: Man, Economy, and State Chapter 10 ; Human Action Chapter XV.5 * Does competitive mean perfect competition? When Neoclassical economists refer to “perfect competition”, they have a very particular model in mind. Under conditions of perfect competition, all firms in a market are producing a single homogenous product. None of them are large enough to influence the market price, so they are all price takers. One may notice that under this scenario, there is no actual competition! It has all been assumed away! All the products are the same, the prices are the same, and the firms producing them are the same. Austrians, recognizing competition as a process in markets and not a state of markets, reject this model. * References: Man, Economy, and State Chapter 10.5 * What is equilibrium? Equilibrium is the state of markets where the supply of a good equals the demand for that good. This is, by definition, the optimal state for a market to reach, as the sellers of a good find their psychic income optimized by having the greatest amount of goods sold, and the buyers’ psychic income is optimized by being able to procure the greatest amount of a good. *References: Man, Economy, and State Chapter 3.9 * How are prices formed? Prices are formed via the evaluation of a good on individuals' value scales, which is compiled into market-wide supply and demand schedules. We can demonstrate this with an example: Suppose there is only one good in an economy: Widgets. It is the only good supplied and demanded on markets. Suppose further that there are only three people who supply widgets, and three people who demand them. To simplify the example as much as possible, we will also adopt dollars as our medium of exchange in this imaginary economy. Person 1 is a widget enthusiast. He buys more widgets than anyone else. We can show this on his value scale, which is an ordinal ranking of all the goods he desires. 1. $10 2. First Widget 3. Second Widget 4. $9 5. Third Widget 6. $8 7. Fourth Widget 8. Fifth Widget 9. $7 This value scale shows that at a price of $7, Person A will demand 5 widgets on markets. If the price rises to $8, he only demands 3 widgets, he values keeping that marginal dollar more than purchasing those two marginal widgets. Let us imagine that the other two individuals have value scales as such: 1. $10 2. $9 3. First Widget 4. $8 5. Second Widget 6. Third Widget 7. $7 1. $10 2. First Widget 3. $9 4. $8 5. Second Widget 6. $7 With this data, we can construct a demand schedule for the market for widgets. To do this, we look at each price and see how many widgets are valued by individuals above that proposed price. We add these up, and that tells us how many widgets will be demanded at each price. - $7 = 10 widgets - $8 = 5 widgets - $9 = 3 Widgets - $10 = 0 widgets This gives us a demand schedule, which if graphed, would equate to a demand curve. The same can also be done with the supply of a good in the economy. However, the order in which the goods appear is reversed. 1. Fifth widget 2. Fourth widget 3. 10$ 4. Third widget 5. $9 6. Second widget 7. $8 8. First widget 9. $7 For the suppliers of a good, the amount of widgets that they bring to market increases as the price goes up. As a result, the third first widget is on the bottom of their value scales, and their last widgets are on top, the reverse value scale of the buyers. Let us say that all of the value scales from the suppliers can be amalgamated into the following supply schedule: - $7 = 2 widgets - $8 = 5 widgets - $9 = 7 widgets - $10 = 9 widgets Given both the demand and supply schedules, we can compare them and see where the market will be in equilibrium. At the price of $8, there are 5 widgets supplied on markets and 5 widgets demanded. This is where the market will be in equilibrium and the price will settle. This example is simplified by dealing with only one good, but this framework can be easily applied to a much more complex economy with many goods. In such a scenario, the value scales are much longer and contain numerous kinds and quantities of goods. Even so, it can be examined with the identical method that we have utilized in our simple example above. *References: Man, Economy, and State Chapter 4.2 * What is the Evenly Rotating Economy? Markets are always working to reach equilibrium, as a state of equilibrium is the most optimal market configuration. However, change is always being introduced to markets, and thus, equilibrium is never reached. The Evenly Rotating Economy is the mental image of an economy if there was no change and equilibrium was reached in all markets simultaneously. This model gives us insight and understanding into the nature of profit, as well as interest, by looking at an economy where there is no change. Profit disappears in the ERE, as the future prices of all consumer goods and inputs are all known beforehand. As such, profits will vanish altogether. This tells us that profits are a feature of uncertainty on markets, and not a permanent return earned by businesses. In the ERE, interest would still exist. If I lend out money for a year, I still expect a return on that money even if there is no risk associated with that loan. *References: Human Action Chapter XIV.5 * What is the function of the entrepreneur? The central problem of an economy is deciding what to produce and in what quantities it should be produced. It is the economic question. The market economy answers this question through the entrepreneurs. It is the entrepreneur that oversees the production of goods and services throughout the economy, as well as the development and creation of new goods. *References: Human Action Chapter 10.8 , Man, Economy, and State Chapter 8 * How do prices coordinate the economy? The entrepreneur carries out the market function of what to produce and how to produce it. However, he utilizes a tool to evaluate his production decision’s success or failure: prices. The entrepreneur observes two prices in particular: the prices of his outputs, and the prices of his inputs. The price of his outputs is a reflection of the consumer’s valuation of his goods and services. If the consumers value these outputs highly, then their price subsequently will increase. If they value them relatively lower, the price will decrease. Thus, he is always looking to the prices of his inputs to relay to him the value that consumers place upon his produce. The other price he must be attentive to is the price of his inputs. His inputs are the prices of all the tools and resources that contribute towards creating the final end product that he sells to consumers. Entrepreneurs are always in competition for these resources and are always looking to employ the most productive inputs for the lowest price. Similar to consumers, the valuation that entrepreneurs place upon inputs will determine their price. These two prices are utilized by the entrepreneur in his quest to make profit. His job is to find where a good can be produced that has a higher value judged by consumers than the value his inputs have been given by entrepreneurs. This process serves a vital societal function as well. This constant pursuit of profit ensures that goods will only be produced where the consumer’s valuation of that good is equal to or higher than alternative goods those inputs could have created. If they are not, the entrepreneur will take a loss and look to changing the lines of production he oversees. The profit/loss mechanism shows us how prices coordinate an economy. The valuations of consumers, their tastes and likes or dislikes, are reflected in the prices of consumer’s goods, which is reflected in the prices of inputs for those consumers goods. Entrepreneurs look to these prices to tell them where they should invest and produce to make a profit. All of this operates through the market function of prices, and without them, economic calculation in an economy is impossible. *References: Human Action Part Three: Economic Calculation * Can demand curves slope upwards? The Law of Demand would suggest to us that an upward sloping demand curve is an impossibility. After all, as price increases, demand decreases and vice versa. Some dispute this by bringing up examples where goods are seemingly in higher demand as the price increases. Designer clothing is an example of such a good; they keep to be more desired by consumers at higher prices than at lower prices. These goods are sometimes called “Giffen Goods”. However, an explanation for this phenomenon is clear: these goods are not the same good! A stock of a good is defined as a stock where all the goods are equally serviceable. However, it is clear that in the case of a Giffen Good at a lower price is less serviceable at a lower price than at a higher price. Thus, the two goods are separate and have separate demand curves. Do prices convey knowledge? One of the functions of prices in a market economy is the transmission of knowledge. It is this fact that is the subject of one of Friedrach Hayek’s famous papers, “The Use of Knowledge in Society”. His point is that prices convey knowledge much more efficiently than word-of-mouth or direct transmission ever could. For example, let us say that an iron mine that supplies 50% of the world’s supply of iron collapses. Obviously, the world has much less iron to use now, and they must ration it much more scrupulously than they did before the collapse. One way to get the information out about the collapse of the mine and the lower supply of iron is by telling everyone that uses iron. You could send them emails or text messages individually telling them to use less iron. A much more efficient method, however, is present in the price system. If the price of iron rises by 50%, producers that use iron will automatically know that they must use less iron because they cannot afford to use as much as they did before. Additionally, the price system gives us a way of knowing who should now get the lower quantities of iron. Those that can afford the higher price will be able to do so only because the good they produce with it is valued by consumers highly enough to afford it. Those submarginal producers will be left without because consumers value their goods relatively lower than others. The price system transmits the knowledge of the collapse of the iron mine in an instantaneous manner and allows that information to be naturally incorporated into the production structure without the need for direct contact or fiat order. *References: Hayek’s The Use of Knowledge in Society * What about Monopolies? The Austrian conception of monopoly is very strict and definable, something that the Neoclassical version is not. Austrians see monopoly as being a privilege granted by the government to favor one firm over all others. It allows one or a few firms to produce a good or service, such as in the case of broadband internet, but does not allow for a free market. The Neoclassical definition of a monopoly would accept that this is a case of monopoly, but that monopoly is much broader than this. They would argue that monopoly has to do with a monopoly price that a firm is able to achieve, which is higher than the price that would have resulted on a competitive market. A firm may grow too large on a free market and then raise its prices; everyone has to go to this firm to buy the good or service, so it can charge a monopoly price and raise its own income. This conception of monopoly was critiqued by Murray Rothbard in his “Man, Economy, and State”, where he argued that there is no way to separate the “monopoly price” from the “market price”. If there is an increase in the market price, this could very well be a result of higher demand or lower supply. In reality, there is no such thing as a “monopoly price”. The only price we have is the market price, which ensures that we cannot make a rational distinction between two different types of prices. *References: Man, Economy, and State : Chapter 10* What is the pure rate of interest? The Pure Rate of Interest is the rate of interest on markets abstracted from all kinds of risk. It is a reflection of the time preferences of individuals and nothing else, as there is no risk of non-repayment that would drive the rate up. * Man, Economy, and State Chapter 3.7 * What is Says Law? Says Law is the law of economics that states that the demand is a product of supply. For anyone to have money to demand other goods, one must first have produced something. I have to produce before I can buy anything. I receive money from producing, which is proportional to the amount of other goods I can demand; I can only buy as many goods as the amount of money I have. This situation is true for everyone in the economy as a whole. Thus, the entire demand for goods is equal to the entire supply of goods. Demand is derived from supply, and is equal to it. Therefore, aggregate demand and aggregate supply are always fused at the hip to each other. Consequently, there is no such thing as a general glut of goods. There cannot be “too many goods” on markets, because the demand necessary to purchase them is always present, as a function of supply. Money: What is money? Money is that object in an economy which serves as a common medium of exchange. Whatever all other goods are trading against is money; it is fully one-half of all transactions. There are three main functions that money serves. It acts as a medium of exchange, which signifies that it exchanges for goods on markets. It acts as a unit of account, allowing for businesses to tabulate and record their revenues and costs. It also serves as a store of value, granting to individuals the ability to save money without the fear of it deteriorating or becoming unusable. *References: Man, Economy, and State Chapter 3.2* What is inflation? Inflation is an increase in the supply of money in an economy. It is possible, and indeed quite probable, that this increase will result in price inflation, which is the increase of prices all throughout the economy. However, this does not necessarily result, as it is possible that the demand of cash balances will increase at precisely the time the inflation occurs, and prices remain roughly stable. However, even in this scenario, prices are higher than they otherwise would have been. *References: Man, Economy, and State Chapter 12.11 * What is deflation? Deflation is the opposite of inflation; it is the reduction of the supply of money in an economy. Similar to inflation, it often leads to a decrease in prices throughout the economy, but this is not a necessary result. *References: Man, Economy, and State Chapter 12.11 * Is deflation bad for the economy? Certain economists, especially those in the Chicago tradition, hold that deflation negatively impacts the economy, and that a certain level of tempered inflation is necessary for the economy to function smoothly. Austrians reject this view, seeing deflation in its natural form as beneficial and good. Deflation embodied in individual prices serves as a boon for consumers, as it means that a good can be acquired for a lower price than previously. Even on a macro level, a decrease in all prices across the economy would indicate that society as a whole is richer, as more goods can be obtained with a fixed amount of money than before. However, deflation that occurs through artificial processes, such as a steady decrease in the money supply, can have harmful effects. Similar to a situation with an increase in the money supply through inflation, those who have their incomes reduced last will benefit at the expense of those who have their incomes reduced first. As long as deflation is through the natural, or good’s side, of the equation and not through the artificial, or money side, of the equation, Austrians believe there is nothing to fear. *References: Deflation and Liberty by Jorg Guido Hulsmann * What is the price level? Can you measure it? Austrians soundly reject the entire notion of a “price level”. Prices are individual points of exchange in a market economy. How could they be at any such level? They are all constantly changing and in flux; increasing and decreasing all the day. The “price level” is not anything that exists and is observable on markets. One could argue that if all prices rise, we can say that the price level has increased. However, we could just as easily say that all prices have increased! There is no need to create a new concept for such a phenomenon. Additionally, not all prices will have risen in the same amount. Some will have risen more, some risen less. As a result, there is still no true way of measuring a price level in this scenario either. *References: Man, Economy, and State Chapter 11.13 * What is interest? Interest is an ever-present phenomenon of the market, and represents the time preference of society as a whole. The interest rate is the rate on present goods saved up and available in exchange for future goods. If there are more saved goods, this interest rate will be lower, and vice versa. If society as a whole has lower time preferences, then there will be more savings, which lowers interest rates. The opposite case is also true. The interest rate pervades all time markets and has a tendency towards an equilibrium state and be equal everywhere across the economy. *References: Human Action Chapter XIX * What is Mises' Regression Theorem? Mises Regression Theorem is the solution proposed by Ludwig von Mises in 1912 to the problem of applying marginal utility to the value of money. The problem lies in that there appears to be an inescapable circle of reasoning in valuing money. I value money because I can buy things with it. The reason I can buy things with it is because it is valuable. However, the reason it is valuable is that I can buy things with it. I’m sure you see the problem here. There is no grounded explanation for how money comes to be valued by individuals. Mises’ solution is that the valuation we have of money today is based on what money was worth yesterday. We make our judgments of money’s value based on the recent past. The money prices of yesterday are based on those of the day before, and so on. This process of regressing back in the past goes all the way until the point that the first commodity money, let us say gold, was not money at all, but simply bartered for on markets. Thus, the basis of valuation of money is based on the past, and this past itself extends all the way until the point where money became money. *References: Human Action Chapter XVII.4 * What is sound vs unsound money? Sound money is that money which fulfills all of the requirements of a money in an efficient manner. These requirements are that it facilitates exchange, acts as a unit of account, and as a store of value. If a money can do all of these things well, it is sound money. Gold is the best example of sound money that humans have discovered thus far, but a better money may someday be invented or discovered. Unsound money is that which does not accomplish the functions of money particularly well. Most fiat money is unsound, especially in that it does not serve as a suitable store of value. Governments are fond of inflating the money supply of fiat monies, making them unsound as compared to alternatives. *References: The Case for the 100% Gold Dollar * What are the merits of sound money? The merits of sound money are that it serves all the functions of money particularly well. Having a medium of exchange in an economy allows for an efficiency of transactions that is simply not possible under a barter economy. A unit of account allows for rational economic calculation to be possible, without which an efficient economy is impossible. A store of value allows for savings to be securely held without their value be diminished as they are held. *References: The Case for the 100% Gold Dollar * What is The Fed? The Federal Reserve, or The Fed as it is often abbreviated, is the central bank of the United States. It was chartered in 1913, although it was not the first central bank of the United States. The mission of the Federal Reserve, as granted by Congress, is to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payment systems. How does The Fed lower interest rates? This topic is a bit complicated, so some nuance will be required here to give an accurate and full picture of what the Fed does to lower interest rates. First, the Fed does not lower interest rates di